Balance Sheet, Profit and Loss Statement, Cash Flow Statement

Balance Sheet

Balance sheet is nothing but another (別の・もう一つの) financial document that we accomplished (have) prepared to provide a user with more information about the financial position of a company. You can look up (調べる) your textbooks for a more formal definition.

Balance sheet is like financial photograph

An analogy (類似) that I like to use, I read another book long time ago was that of a financial photograph. A balance sheet is like a financial photograph. What I mean by that? If you are all sitting in my classroom and I took a picture of you right now, the camera would record your posture at the moment the flash went off.

But one million seconds after, I took the picture, all of your posture could conceivably (おそらく) change. So similarly the balance sheet records the financial position of a company as of (~の時点で) a certain date. It could be as of December 31st 2012 or as of April 30th 2013 etc.

What is an asset?

Now the balance sheet is broadly classified into three main sections, assets, liabilities and stockholders equity also called shareholders equity.

What is an asset? I like to use a one word working definition of an asset as something that the company owns, just as you own a number of things in your personal lives. What are some things that you own? Clothes, a car, may be more than one car, a house etc. All of these are your assets.

Similarly a company owns or can own a number of different items as well. Now for balance sheet reporting purposes, the assets are further sub classified into several sub sections.

Current Asset

The first sub section under the asset group would be current asset, so what is a current asset? By definition a current asset is cash or any other asset that can be converted into cash within one year.

GAAP specifies which accounts for current assets. Here are this illustrated two of them cash and account receivable as examples.

Account Receivable (AR)

Account receivable also called AR, what is an accounts receivable? When does an AR come on a company’s book? AR typically comes about (起こる) when a company sells a product or provides a service on credit on account. On account is another term for on credit, so again if you were a company selling clothes and you sold clothes to a customer on credit, then that creates an accounts receivable on your books.

So in keeping with a one word definition of an asset, and that is something that the company owns. What is it that you the business owner owns, so the company owns when you have an AR?

In this case what will happen is the company owns the right to receive money from the customer at a future specified date. So initially when the company sells those clothes on credit that creates an AR the company’s AR goes up.

When the customer sends the money, makes the payment and the company receives the check. That reduces the company’s AR. So that’s a little bit about how AR comes about on a company’s books and how it goes down.

Property, Plant and Equipment

Next we have other sections that broadly fall into the umbrella(グループ) of long term assets. The first of these subsections that fall under the broad umbrella of long term assets would be property, plant and equipment. And some examples of accounts that fall in the property, plant and equipment subsection would be land and building.

Intangible Assets

Then you have another subsection called intangible assets. Some accounts that fall under this subsection would be goodwill and patents.

Deposit

Then we have another subsection which is kind of a catch-all section called other assets, and one account that typically falls into the other account other assets section will be deposits.

What I mean by a deposit? Let’s assume you are starting a company for the first time and you need to set up an account for the utilities, so you call up the utility company, and because you have no prior history with that company, they say to you send us a check for $1,000 as a deposit.

And once your company establish a payment track record with them, a good payment track record, let’s say for six months, they will return that $1,000 to you. So $1,000 that you send into the company is not a payment for your bill. It’s just a deposit that the company is going to hold till they’re satisfied that you have a good credit record, a good payment record with them, and then they return the money to you.

So your company owned that money all along, hence (So) it’s an asset for you, even though the utility company is physically holding to that cash, and so on your books on the balance sheet you would classify that as a deposit.

So when you add up all of these subsections that will give a total assets dollar figures. So that’s a little bit about assets and the different components that make up assets.

Liabilities

Then we’ll move on (先に進む) to the next section called liabilities. One word definition of a liabilities would be something that the company owes. Do you owe anything to anybody in your personal lives? Most of us do. It would be student loans, it would be a loan for your car, in mortgage on your house (住宅ローン), money that you owe for your taxes, so these are all liabilities to you.

Account Payable (AP)

Similarly a company has various types of liabilities. One would be accounts payable. Accounts payable is an account. It’s a liability account obviously, and it is used when the company purchases items on account for everyday use. So let’s assume that they go to a office supply store like Office Depot or Staples, and they buy supplies on credit. That create an accounts payable on the company’s books

Oftentimes students tend to get confused between accounts receivable AR and accounts payable AP. Well don’t. Look at the words carefully accounts receivable that means the company is going to receive something and one way the company would receive something would be if they were to have sold a product or provided a service.

Conversely accounts payable focus on the word payable. Why do you have to pay? You have to pay because you purchased something, and in this case would have purchased something on credit.

Wages Payable

So accounts payable would be one account wages payable. You’re an employer. Every day your employees come to work for you. But do you pay them every day? Probably not. So at the end of each day let’s assume you pay them once a week on a Friday. So when your employees finish working for you on a Monday, don’t you the employer owe them some money as of (~の時点から) the end of that day for the work that they’ve done? Yes, you do. And the next day when they come in and do another day’s worth of work, you will now have owe them for two days Monday and Tuesday.

So this these items will be reflected in terms of wages payable. And when do the payable get off your books? The payable go off your books? Once you make a payment. So whether it be a payment to Office Depot or Staples or whether it be a payment to your employees, once you make a payment, that brings your payable down.

Current Liabilities

Then both of these payable both of these accounts come under the current libraries section. Now what is a current liability? A current liability would be basically a liability that you will pay off within one year now.

Lont-term Notes Payable

The next subsection under liabilities would be long-term liabilities. Then again you could have different accounts, I just illustrated one account long-term notes payable. You buy a car for instance, you sign a promissory note with a bank. And oftentimes those car payments are made over many years. So all those payments that you have to make all the principal balance that you owe on your car pass one year after making one your payments. That principle would be reflected in your long-term notes payable. The amount of original loan that you have to pay off within one year that would be classified in the current liabilities section.

Stockholders equity

Then we’ll talk a little bit about the stockholders equity. One way to understand the stockholders equity would be the owners claim (請求) on the assets of a company. And typically again there are different accounts that make up your stockholder equity. One would be common stock. When does common stock come a on company’s book, when you first form a corporation. In consultation with your attorney (代理人) you will file(申請する) that necessary paperwork and as a result of that you will issue what I called shares.

Shares are another word for stock. When company owns only one type of stock, it’s common stock. If a company chooses later to sell a second type of stock that would be called preferred stock(優先株), so common stock represents ownership interest in a company.

If you and your friend hypothetically were to start a company, and you all decided to issue 1,000 shares and you own 400 of those 1,000 shares, then your ownership would be 40 percent of the company.

But all of the 1,000 shares would be reflected in the common stock account. Now when you first issue common stock in consultation with the attorney, you also and also based on state regulations you have to establish a value for that shares. That value is a some arbitrary (任意の) value, but it has a lot of legal implications(意味合い) could be called a stated value or a par value depending on your state regulations.

Retain Earnings

Retain earnings is an example of another account within the stockholder equity family The retained earning account typically holds the company profit. Every month as a company generates profits. Those profits go into the retained earning account. So retained earning accounts keeps increased every time the company generates profit.

Conversely every time the company has losses, the retained earning account decreases. Another type of transaction that causes your retained earning to go down would be that payment of dividends.

Dividends are a distribution of the company’s profit to the shareholders, and so every time a company declares dividends then those dividends come out of the retained earning account, because that’s where the company’s profits are held. Another way to understand stockholders equity is to think of that as a net worth of a company. We don’t use the term net worth as it related to companies but we trend to use the words net worth as it relates to us individuals.

    • Net Worth (Stock Holder Equity)
      • Common Stock (普通株): Stock when first formed corporation
      • Preferred Stock (優先株): Second type of stock that company sell  later
      • Retained Earnings: Generated by profit
        • Net Loss
        • Dividend: Distribution of company’s profit

So you all have heard of the term a millionaire. Think about it, what makes an individual a millionaire? If I want to have a million dollar houses, does that make me a millionaire? And the answer is no, not necessarily. So what makes me a millionaire then? If you look at the accounting equation here, total assets equals total liabilities and stockholders equity, that’s assets equals liabilities plus equity.

If you rearrange the equation your stockholders equity would be the difference between your total assets and your total liabilities. So in order for me to be a millionaire, I would have to have the difference between my assets and my liabilities to be at least a million dollars.

So going back to my earlier example. If I were to buy a million dollar house, let’s assume I don’t own any other assets, just for simplicity sake(目的) just that one asset. But I owed if I borrowed nine hundreds thousand dollars to buy that house, that means my stockholders equity then would only be the differential one hundred thousand that hardly(ほとんど~ない) makes me a millionaire. May give me bragging (自慢) rights that I have a million in our house but it does not make me a millionaire. However another hand if I bought a million dollar house with cash outright(完全な) cash and I don’t have any other liabilities, then I could say I’m a millionaire because the difference between my assets million dollars and my liabilities is zero is equal to net worth or equity of 1 million dollars.

So that’s an overview of the balance sheet containing the three broad sections assets, liabilities and equity. We have gone through the different subsections. Wherever applicable we have talked about accounts, and let me leave you with this thought, one way to understand accounts is think of their assets liabilities and equity as families. And just as in the human family, there are family members each of these account again, represent family members that belong to each of the three broad family group.




Income Statement

I’m going to explain to you the mechanics (力学) of an income statement. So to help you understand this concept a little better, behind me I have put up some information and a simplified income statement on the whiteboard here. So let’s talk about the income statement now.

What is the income statement? Let’s look at some terms that I used to describe the income statement, also called the statement of income and expenses, also referred to popularly as a P&L statement P and L profit and loss statement.

So in the sample here the income statement should always identify the name of the organization. I have taken the liberty of putting the name of my company Lazarus global business solutions.

Right below that you have the name of the statement, in this case income statement.

Time Reference

And then below that equally important is a time reference. What time reference do you see here? We have put for the month ended March 31st. So when we put a time reference, it helps you, the user of the statement put all of these numbers in context (put~in context 文脈の中でとらえる), because now you know that these numbers are associated with a one-month period and the month namely (すなわち) is a month of March.

So you can prepare an income statement for almost any period of time. You can prepare an income statement for one year or for six months or for a quarter or for a month. You could in theory also prepared an income statement for a period less than a month. Do we journey don’t do that. Because if you prepare an income
statement for a period less than a month, let’s say like for one week for instance, that is too short a time period for the information to be relevant (適切な) and meaningful. More on that little later.

Revenue

So what type of information does the income statement contain? Basically you can see here the first section is the revenue section. In the revenue section we show all the revenues that the company has earned during this period of time.

And under the revenue section you can have as many sub accounts as you want. So for instance if I were a clothes store hypothetically and I was selling men’s clothes women’s clothes and children’s clothes, I could have under the revenue section a sales account for men’s clothes, sales account for women’s clothes, sales account for children’s clothes etc.

Or since (~の故に) I’m a consulting practice, I can have a different kind of a breakdown, since I am a service organization. I will not have the word sales, but I will instead I could use a word fees earn or service revenue. I could substitute (替わりに用いる) that as easily, but if I’m selling merchandise, then I will have sales accounts in addition to the fees earn again, don’t depends on what type of services are providing or what type of merchandise I’m selling. But to summarize you’re going to have the revenue information on top, and then below that you will have information on expenses.

Expense

So you could have your cost of goods sold as an expense and you can have a whole bunch (束) of other expense accounts salaries expense, rent expense, interest expense, advertising expense etc. So you would normally list all of your different expense accounts as well.

Net Income or Net Loss

And then you have your net income or net loss. How do we derive (引き出す) that? We take all of our expenses and we subtract that from our revenues, and the resulting number would be a net income. If your revenues are greater than your expenses, conversely if your expenses are more than your revenues, you will end up with a net loss.

So this net income or net loss is what determines the profitability of the company. So if somebody asked me is my company profitable, I would look at my income statement and see if I have a net income or net loss, if I have a net income I will say yes my company is profitable, if I have a net loss I’ll say no, company at this point is not profitable although I hope things will change in the future.

So that gives you a quick overview of the income statement with a sample format.

One month is the shortest period for income statement

Now going back to a point I made earlier when I said normally we don’t prepare income statements for a period less than a month.

That’s assume for a moment we decided to prepare the income statement for only a week, and let’s assume that we are doing this for the last seven days and let’s further assume that we had very heavy snowfall in the last seven days.

If that’s the case how much sales do you think my computer store would have? Or if I’m selling clothes how many sales do you think I would have? Not much isn’t it. But I still would have expenses.

In other words my landlord is not going to give me a break on the rent because we had snowfall for a week. I’m so I’m still gonna have rent. I’m still gonna have utilities. If I have a manager on a salary, I still have to pay him on her. So I still would have a lot of expenses for that last week, even though my sales would be very little. My revenues would be very little and I would probably have a net loss for that week.

But to show that net loss just for one week would be kind of meaningless because probably I could make up the revenues over the next few weeks as the weather improves.

So again to recap the income statement can be prepared for any period of time. But one month usually is a shortest period of time for which we prepare that income statement, and then comes late and contains information on your revenues and your expenses as well as your net income or net loss. So that’s a brief overview of the income statement.

Cash Flow Statement

We will talk about the cash flow statement, also called the statement of cash flows. I have provided a simplified sample format of the cash flow statement here by my side, and we’ll go through that and get a better appreciation (真価が分かる) and an understanding of this important document.

So you start up at the top by identifying the company name. I have taken the liberty of putting my company there Lazarus global business solutions. The next line identifies this document as the statement of cash flows.

Time Reference

Then the third we have a time reference. In this case the time reference says that this cash flow statement is prepared for the month ended March 31st.

The time reference is important, because it helps to put all the numbers in the proper context, because even before you start looking at the numbers, you know that the information you’re about to (まさに~しようとしている) look at is for a one-month period.

Three sections of cash flow statement

Now the cash flow statement is broken into three broad sections. The first one is the operating activity section, then you have the investing activity section, and finally you have the financing activity section.

Two method of preparing cash flow statement

There are also two different methods for preparing the cash flow statement, the direct method and the indirect method.

So what’s the difference then between the two methods? Well the main difference between the two methods is in the operating activity section. The way we calculate the numbers in the operating activity section is different under the two methods.

However the remaining two sections, the investing activities and the financing activity section, those two sections are identical (同じ) in all respects(点) under both the methods. So how do we know when we have a cash transaction. How do we know which of the three sections it goes into? Well let me give you some broad guidelines and run through some numbers in our sample statement here.

Operating Activity Section

Let’s take the first section the operating activity section. The broad guideline here is if a cash transaction affects your revenues or your expenses, then we would tend to classify that in the operating activities section.

Now here in this example under the operating activities we have cash collected from our customers in the amount of $450 and then below that we have another item cash paid to vendors for $400. So between the two when you combine it we end up having a $50 cash inflow from the operating activities section. So we have a 450 cash inflow, a 400 cash outflow, that results in a net inflow of $50 from your operating activity section.

Investing Activity Section

Then the next section we have is the investing activities. What goes in here? A broad guideline as to what goes in here would be purchase or sale of your long-term assets or any investments long-term investments. So in as an example here I have one item that says cash from sale of land. Cash from sale of land one thousand dollars. So in this case is this is the only item we end up with a $1000 in flow from our investing activity section.

Financial Activity Section

Then we have the financing activities section. What would be the broad guideline as to (~に関して) what goes in here? Transactions that affect your long term debt as well as your equity accounts would be classified in your financing activity section.

We have one item mentioned here cash from loans. This is cash that you receive from taking a loan in the amount of $150. So since this is the only item here we have a cash inflow of $150 from the financing activity section.

So when you add up all of these numbers, you end up with 1,200 dollars of cash inflow coming in this month from the three sections combined. Below that is it let’s assume that you had started off the month with a $20 cash balance. So if you started off the month with a $20 cash balance and you received $1,200 during the month net between your inflows and your outflows. Then you end up with a ending cash balance of one thousand two hundred and twenty dollars

So this is a simplified version of the cash flow statement with some information about the different sections to help you better appreciate and understand the cash flow statement

So when you go back to your textbooks and look at a more detailed format, hopefully you can take some of these guidelines that I’ve shared with you and that will help you better appreciate and understand in much more detail cash flow statement.